Monday, October 02, 2006

Something's Gotta Give

EUR/USD 1.2692 Hi 1.2696 Low 1.2661
USD/JPY 118.16 Hi 118.42 Low 117.85
AUD/USD 0.7447 Hi 0.7459 Low 0.7440
EUR/JPY 149.95 Hi 150.05 Low 149.48

Well it's going to be an interesting week. In Europe we have the ECB meeting and everyone is expecting a 0.25 point hike. The fascination will centre around whether Trichet and his team choose to emphasize "extreme vigilance". Indeed, even the term "extreme vigilance" is being poured over and analysed. What does it mean? How does it translate? What a fuss. The ECB is the old school kind of institution which thinks that credit growth is a no-no. The Germans haven't yet recovered from the Weimar Republic monetary policy fiasco and the French don't want to appear any less rigorous than the Germans. And so we go with "extreme vigilance" and the gradual squeezing out of supposed monetary accommodation in the EuroZone.

The fact that the German track record with regard to monetary policy is spotty seems to have escaped everyone's notice. After all, Weimar was a German fiasco and the approach of the Bundesbank to monetary policy post German Unification won't exactly go down in history as a text book example of how to manage inflationary expectations. Post Unification the Bundesbank over-reacted to a one-off inflationary threat and took the EMS to breaking point. Oh and they did a pretty good job engineering a recession in Europe from which Germany is just recovering.

No matter, they have gravitas, good suits and they don't joke around. And don't you think that the French can't keep pace with that, because they can. Rigour, the French can do rigour. Just watch. Let's hope that the French can also recognize overkill when they see it. Anyway we'll get 25 points this week and maybe another 25 points by the end of the year. After that a lot will depend on what happens to the global economic environment. Don't mention the war and don't mention that the Bundesbank wasn't as good as their shining reputation.

Meanwhile in the U.K. there seems to have been something of a cock-up in the statistics department. While there has been a lot of guffawing in the U.K. press about the recent Greek decision to revise GDP numbers, a serious miscalculation at the British National Statistics Office means that inflation in the U.K. is considerably lower than previously stated. Expectations of further rate hikes in the U.K. have been downgraded and now no-one expects a rate hike in the U.K. this week. But then again no-one expected the last rate hike either. Sterling came out of the revision a little battered but, while Central Banks continue to move out of USDs and into alternatives, the longer term outlook for the currency remains positive. Sterling is still seen as the Euro proxy with interest rate benefits. And Central Banks of the world are buying.

Friday sees the release of Non-Farm Payrolls in the States. No-one is expecting the U.S. economy to rebound in the short term. The employment statistics will be poured over to see if the slow motion crash underway in the U.S. Housing Market is impacting economic activity in other areas. The only argument going on out there is: soft or hard landing? The jury is still out.

For now the markets are relatively calm. Volatility is near record lows and everyone is going with the friendly Carry Trade. What's interesting about that is that Hedge Funds have been blown away recently in the midst of what is supposedly a quiet market. One fund managed to lose 11% last week. If the fairly mild correction recorded in U.S. Treasuries last week could lead to these kind of losses then the potential for a more serious correction in the Treasury market could see things really get interesting.

For now, despite all the talk of slowdown, the Treasury market has not responded. And the market is overwhelmingly bullish Treasuries. So there is potential for another Amaranth-type misadventure. Watch this space.

OIL 62.90
GOLD 607.30

GOLD remains steady. OIL is in a range.

The chatter in the markets is: what's with COPPER?? The idea is that the Housing market problems in the States and a global economic slowdown next year will take the shine off COPPER. Given the spectacular rise in COPPER over the past two years, the big idea out there is that there is an accident waiting to happen. Meaning: the vultures are lining up waiting for COPPER to break to the downside. Questions are being asked about existing speculative positions. It could be interesting. Now, which Hedge Funds are very, very long COPPER? We'll soon find out.

But back to OIL. Just as the whole Iran scenario was starting to look positive, and OIL prices were falling, Rice is back out there talking about Iran. Condoleezza Rice is back on the interview circuit. It doesn't look good. Rice is talking up the nuclear risk as she heads for another round of talks with U.S. allies in the Middle East. This news, in the absence of anything more significant, will keep the floor under OIL for now. Alone in the Commodity Universe, GOLD and OIL continue to outperform.

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